CAD Net Employment Change (JAN) (12:00 GMT; 07:00 EST) Expected: 11.0K
Previous: -18.7K

Unemployment Rate (JAN) (12:00 GMT; 07:00 EST)
Expected: 6.0%
Previous: 6.0% (R+)

What Are The Markets Facing?

Canadian economic conditions were rather resilient throughout 2007, though the strength of the Canadian dollar started to show through in the deterioration of trade and manufacturing reports towards the end of the year. Indeed, Ivey PMI plummeted below the 50 boom/bust level to a six-year low of 45.9 in December, signaling contraction in the business sector. Meanwhile, December labor market data reflected a net loss of workers, as the employment change unexpectedly fell by 18,700. However, it appears that the beginning of 2008 was a bit better for the Canadian economy, as Ivey PMI recovered to a lofty 56.2. A breakdown of the report showed the employment component rose above the 50 level, signaling expansion and boding well for Friday’s labor market reports. The Canadian economy is expected to have added a net 11,000 workers during December, which would keep the unemployment rate at 6.0 percent. The release of the net employment change tends to be quite market-moving, particularly when it comes to FX, as the actual figure rarely meets economists’ estimates. Over the past few months, the surprise has generally been to the upside – with the exception of last month – which has proven to be bullish for the Canadian dollar. Given the recent improvement in Ivey PMI, the January labor market readings could be far more optimistic than last month and may lead traders to cut back on speculation that the Bank of Canada will cut rates on March 4.

Bonds – 10-Year Canadian Government Bond Futures

After bottoming out near 115.75, Canadian government bonds have rallied quite a bit amidst a return to risk aversion. The contract has blown through resistance at 117.03 and is targeting the 117.44/50 area, but the release of Canadian employment data may weigh CGBs down. The news could lead traders to cut back on speculation that the Bank of Canada will cut rates at their next meeting and lead CGBs towards 117. On the other hand, another surprise contraction in the labor force could propel the contract up towards 118.

FX – USD/CAD

After last month's disappointing net employment change of -18,700 led USD/CAD to rally significantly, traders will be wondering if a stronger-than-expected number will do just the opposite this month. A strong labor base combined with the increased optimism in the manufacturing sector - as signaled by the better than expected Ivey PMI Survey - may foster the belief that the Canadian economy is better poised than the US to avoid a recession. If this is the case, there would be no need for further rate cuts by the Bank of Canada, which could help the Loonie and break the USD/CAD pair from its current consolidation near parity. On the other hand, a disappointing print may signal that the BoC has more work to do in avoiding a major economic slowdown, which could weaken the Canadian dollar as it did last month. Indeed, it has become evident that the rest of the world is starting to become infected by the US slowdown, as the Bank of England recently lowered interest rates.

Equities – S&P/TSX Composite Index

Despite rallying off of the yearly low of 12,011 on January 22 after rate cuts by the Bank of Canada and the Federal Reserve, the S&P/TSX index still remains down over 4% for the year. Although recession fears have started to dissipate on the belief that the rate cuts will start to propel growth, investors are still proceeding cautiously as labor data has printed weak for both the US and Canada and amidst concern that consumption may deteriorate further. However, the Canadian unemployment rate is expected to remain unchanged at 6.0 percent and the net employment change is expected to increase by 11,000 jobs, which is a significant reversal from last month’s loss of 18,700. A stronger than expected number may send equities soaring as investors may suspect that the Canadian economy is in better shape than its southern neighbor. Indeed, this is a real possibility after the Ivey PMI came in significantly better than expected at 56.2 with a strong employment component that jumped 4.8 points.

Terri Belkas is a Currency Strategist at FXCM.